Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.

Don't Be Suckered by These Investments

You should never pay more than you need to.

There are lots of things I love about mutual funds: their convenience, diversification, expert management, and (sometimes) solid performance. But if you're not careful, the wrong funds could cost you far more than you ever wanted to spend.

Too many investors cough up too much in fees to the funds in which they invest. The folks at kaChing run a portfolio management service in which you can replicate the portfolios of high-performing members. They found that on average, mutual funds charge their shareholders more than 3% annually. That should surprise you; most funds quote expense ratios between 1% and 2%. But those yearly expenses aren't always the only fees involved.

The fees you don't seekaChing detailed the following undercover costs:

Fee

Average Actively Managed Mutual Fund

Management fee

0.69%

Trade commissions

0.10%

Soft dollar commissions

0.10%

Marketing fee

0.53%

Other expense fee

0.47%

Front-end load

0.32%

Back-end load

0.22%

Other investors' tax liability

0.94%

Total

3.37%

Source: kaChing.

These are averages, of course. Many funds charge no sales load at all, while those that do sometimes charge nearly 6%! Some funds levy hefty marketing fees, while others charge little or nothing on that front.

Funds often quietly pay commission expenses to brokerages, while the other investors' tax liability reflects the cost, on average, that shareholders bear in taxes due on gains a fund made before they added their money to it. For instance, if you bought into a fund in October, you'll end up with a year-end tax liability as a shareholder on gains the fund realized over the many months before you joined it. Ouch.

Choose your solutionsA 3% or more bite out of our mutual fund performance is a big deal, because every percentage point counts. Imagine two funds whose investments manage to earn 10% over 20 years. One charges 3%, while the other charges 1%. The 3% fee will reduce your annual gain to 7%, turning a $10,000 investment into $38,700. The 1% fee will leave you with 9% and $56,000. See the difference?

Clearly, you can find good funds that charge much less than 3.37%, but you may have to hunt them down. Consider calling the fund company and asking for a breakdown of fees, both listed and unlisted.

You can also minimize your fees (and your labor) and earn nearly the same return as various indexes by investing in inexpensive index funds. For example, here are some lesser-known index funds beyond the S&P 500:

Index Fund

Expense Ratio

10-Year Avg. Ann. Return

Selected Holdings

Vanguard Total International Stock Index (VGTSX)

0.27%

2.1%

Rio Tinto(NYSE:RTP), Total SA

Vanguard Mid-Cap Index (VIMSX)

0.22%

6.0%

priceline.com(NASDAQ:PCLN), Micron(NASDAQ:MU)

Vanguard Small-Cap Index (NAESX)

0.23%

3.4%

DreamWorks Animation(NYSE:DWA), Oshkosh(NYSE:OSK)

Vanguard Balanced Index (VBINX)

0.20%

2.8%

AT&T(NYSE:T), Altria(NYSE:MO), various bonds

Data: Morningstar.

If you'd like pointers to high-performing funds -- both managed and index-based -- take advantage of a free trial of our Rule Your Retirement newsletter. You can see our full archive of concise and practical retirement guidance, along with stock and fund recommendations, free for 30 days.

Author

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter... Follow @SelenaMaranjian